The International Monetary Fund has identified several challenges and risks that could arise from the eventual tapering of the Federal Reserve’s quantitative easing programme.
In a recent check-up report on the US, the IMF runs through scenarios of the end of the Fed’s $85bn-a-month bond-buying programme and the impacts these could have on the economy. Some of these stem from the fact the Fed owns more mortgage-backed securities than initially expected.
Considering a passive run-off of QE, the Washington-based think tank says: “Assuming QE-related purchases continue through June 2014, it would likely take about five years for the treasury portfolio to revert its historical norm.
“The MBS portfolio all take much longer to wind down if the Fed relies only on passive pay-downs, since prepayment speeds will likely slow as interest rates rise.”
The IMF identifies the different environment the Fed faces to when it began the QE programme as it now has a balance sheet of almost twice the size – at just over $3trn – and a portfolio with a much longer duration.
With the Fed first planning its exit strategy from QE at a Federal Open Market Committee meeting in June 2011, the IMF says: “When the Fed first outlined this strategy, the committee had expected to start unwinding its strategy via outright sales of agency debt and agency MBS sometime thereafter over a three-to-five year period.
“But since then, the Fed has put less emphasis on asset sales, owing to concerns about market disruptions.”
In terms of further correcting the market and “draining” elevated excess reserves in fed funds, the IMF report warns about the challenges this poses due to the swollen size of the central bank’s balance sheet.
The IMF says: “Since the Fed originally laid out its exit strategy in June 2011, the balance sheet has grown even larger, with the securities portfolio expanding by an additional $500bn, which further increases the challenge for managing draining operations and exerting control over short-term rates.”
While the report highlights the improved communication and guidance from the Fed and the now-broader toolkit at its disposal, the IMF also raises the importance surrounding the issue of ‘term premium’. The fund argues that a number of factors, such as concerns over US growth and confusion over the Fed’s policy direction, could make investors less willing to hold longer dated bonds over their shorter dated alternatives.
The IMF says: “If protracted, such pressures could weigh on the recovery and have negative international spillovers.”